Integrating climate risk into risk management frameworks

As financial firms begin to transfer lending and investment from carbon-intensive to carbon-neutral firms and clean technologies, more sectors and financial firms will begin to feel the effects. In a Risk.net crowd-sourced scenario-generation exercise, it was revealed that people expect rising carbon prices to have a big impact on just about every sector, financial index and investment

One of the most promising news stories to come out of negotiations at the 2021 UN Climate Change Conference, COP26, was the announcement that the Glasgow Financial Alliance for Net Zero now has $130 trillion committed to combatting climate change. Additionally, its 450 members – which include banks, insurers and investors – have pledged to become net zero by 2050 at the latest. Firms have agreed to report their progress and their financed emissions annually.

This commitment means the private sector could deliver around 70% of total investments needed to meet net-zero goals, according to analysis conducted for the UN High Level Climate Action Champions.

As these financial firms begin to transfer lending and investment from carbon-intensive to carbon-neutral firms and clean technologies, more sectors and financial firms will begin to feel the effects. In a Risk.net crowd-sourced scenario-generation exercise, it was revealed that people expect rising carbon prices to have a big impact on just about every sector, financial index and investment.

However, even though measuring and mitigating climate risk has become a priority at many financial firms, the discipline is still nascent and poses huge challenges. Modelling climate risk exposures within a portfolio is beset with hurdles. These are discussed in Matthew Lightwood’s article, Applying scenario analysis to climate risk.

While firms are working towards producing their own robust transition plans, many want greater input and clarity from regulators. For example, some banks are calling for regulation to define and set standards for transition lending – loans that intend to aid the transition to a low-carbon economy.

As banks work on integrating climate risk into their risk management frameworks, a debate is currently in full swing around whether climate risk can fit into existing credit risk weights, and how it should be treated when it comes to capital rules. This report explores the credit risk weighting and capital rules issues.

The report also includes a roundtable in Q&A format in which three experts discuss a range of issues from disclosure to climate stress-testing, and from carbon markets to climate metrics, providing insight into how they see these crucial issues developing.

Of course, the price of carbon will play a pivotal role in driving green investment, but currently gas and coal prices also jump to the tune of their own fundamental influences, such as weather, supply and demand, and storage availability. This has been very evident in Europe and the UK in recent months, where soaring gas prices have made coal more economical. An analysis of this situation also features in this report.   

Finally, the 2021 Climate risk special report explores some important issues facing investors, asking whether some environmental, social and governance-type investments have inflated values and whether European Union rules could be encouraging greenwashing.

 

Climate risk – Special report 2021
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